Fees In Mutual Funds

Mutual Fund Fees

Mutual funds are the most popular choice for diversified funds in today's marketplace (though ETFs are fast on the rise, and MLP’s, REITS, BDC’s can be better due to having both dividend and value growth potential). However, for all of their popularity, some investors still do not fully understand the fee structure and all of the possible charges that can be associated with investing in one of these products, and this is what I would like to share with you this week.

•Expense Ratio: The most obvious and up-front cost, an expense ratio or management fee, is paid each year to the fund's management team out of the fund's assets. The average mutual fund charges 1.3% to 1.5% each year, which can add up quickly and eat up your position over time.  When stated as a percentage of assets, average fees do look low — a little over 1% of assets for individuals and a little less than one-half of 1% for institutional investors. But the investors already own those assets, so investment management fees should really be based on what investors are getting in the returns that managers produce. Calculated correctly, as a percentage of returns, fees no longer look low. Do the math. If returns average, say, 8% a year, then those same fees are not 1% or one-half of 1%. They are much higher — typically over 12% for individuals and 6% for institutions.

•Transaction Fees: Most funds will charge a fee when making your initial purchase and some will also charge a redemption fee, which comes when you sell the fund. Both of these fees are paid to the fund, making them different charges than the next two items on our list.

•Front-end Load: This is a fee charged at the purchase of some funds; it is paid to the brokers that sell you the product. A front load is usually charged as a percentage and comes out of your initial investment. If you were to buy $10,000 worth of a fund that charged a 3% front-end load, $300 would go to the broker, while $9,700 would actually be invested.

•Back-end Load: This works the same way as a front-end fee, but it is charged when you sell certain funds. Back-end fees typically taper off as time goes on; for example, the fund can charge 3% if you sell within one year, 2% within two years and so on. These typically won't hurt a long-term investor, but they can be a nasty surprise if you need to exit a position earlier than anticipated.

A no-load fund sells its shares without a commission or sales charge. Some in the mutual fund industry will tell you that the load is the fee that pays for the service of a broker choosing the correct fund for you. According to this argument, your returns will be higher because the professional advice put you into a better fund. There is little to no evidence that shows a correlation between load funds and superior performance. In fact, when you take the fees into account, the average load fund performs worse than a no-load fund.

•Account Fees: Certain companies will charge investors an account fee, which is a cost associated with the maintenance of an account. These include necessities such as postage, record keeping, customer service, cappuccino machines, etc. Some funds are excellent at minimizing these costs while others (the ones with the cappuccino machines in the office) are not.

• The last part of the ongoing fee (in the United States anyway) is known as the 12B-1 fee. This expense goes toward paying brokerage commissions and toward advertising and promoting the fund. That's right, if you invest in a fund with a 12B-1 fee, you are paying for the fund to run commercials and sell itself!

  Not all mutual funds will incur the aforementioned fees, and there are plenty of options that manage these costs quite well. Still, investors should watch out for the fee structure associated with any mutual funds they purchase and be sure that they understand the costs associated with the investment. If a fund has a fee structure that you are not comfortable with, try looking into ETF’s, REITS, MLP’s & BDC’s, those products are often more cost effective and still offer most of the advantages associated with mutual funds, to include dividend growth and greater value growth potential.

Happy Investing

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